Get With The Plan: October 19, 2014

Judah, 53, and Nancy, 52, are juggling a lot of “what ifs” for their eventual retirement.

The couple have two children in their late 20s who are financially independent, but they’d like to stay in New Jersey to be close to the kids and their extended family.

But still, Judah’s job security is not certain, and he fears he could lose his job at any time.

“If that happens I know I can collect an early pension at age 55 but I’m not sure if that would be enough,” he says. “Our retirement income also needs to be able to support both of us.”

In a perfect world, Judah says he’d retire when the money is right, while Nancy would like to 62 or 65,

So far, the couple has saved $282,700 in 401(k) plans, $32,700 in IRAs, $12,000 in savings and $5,000 in checking.

They both have two pensions coming to them.

For Judah, he’d collect $1,518 per month at age 65, and he’d collect another $275 per month at the same age from a previous employer’s pension. Nancy is scheduled to receive $752 a month at age 60 from her first pension, while the second would pay either $283 a month at age 55, or $566 per month at age 65.

The Star-Ledger asked Jim Marchesi, a certified financial planner with Mill ridge Wealth Management in Chester, to help to couple project their financial readiness for retirement.

“They are both willing to downsize from their house to a townhouse, and want to stay in New Jersey, taking a week or two of vacation per year in retirement,” Marchesi said. “Like the dedicated parents they are, it seems they want to be close to their kids in case any grandchildren come into the picture.”

Marchesi ran several projections. One showed what would be needed if Judah and Nancy both stayed employed until age 65, which is when the pensions kick in full force.

“That allows them to contribute to their retirement plans for another dozen years or so,” Marchesi said. “This is significant, as the couple is saving over 20 percent of their incomes in their retirement accounts, including company match and catch up provision contributions.”

Marchesi said this plan assumes they’d have a similar income from now until retirement and their assets would grow at 7 percent a year before retirement.

Marchesi rigorously tested the assumptions if the couple retired in 2026.

“When a couple enters the retirement phase of their lives, their ability to meet expenses from earned income gets greatly diminished or goes away,” he says. “So, the couple counts on a combination of income streams — Social Security benefit payments, pension payments, rental income and so on — and, as needed, a distribution program from their retirement investments to meet their lifestyle wants/needs for over 30 years while in retirement.”

Marchesi says an issue that is much more prevalent for the upcoming retirees than past generations is cost of living adjustments to pensions and Social Security.

“Decades ago, cost of living adjustments, which increase your payments from the previous year’s payments to help offset inflation, were more the norm than the exception,” he said. “Confidence in future increases in these type of payments is waning.”

Marchesi said for Social Security, cost of living adjustments have increased an average of around 1.3 percent per year over the last five years, and in 2009 and 2010 the adjustment was zero largely due to the low levels of inflation.

“The takeaway is that fixed income payments lose their value quickly if there is not an increase in payments over time,” he said. “Inflation is a powerful enemy of money that doesn’t grow.”

He said a payment of say $60,000 in year one, in a 3 percent inflation environment, has purchasing power of only $43,000 in ten years if there’s no cost of living adjustment.

Once the couple retires, assuming no cost of living increases on their pensions or Social Security payments, he said they have to try assigning a rate of return on their investments through retirement.

So using a 3 percent average inflation number in retirement, he inputted three different scenarios for their return on retirement assets: 2, 4 and 6 percent.

“Obviously, if they average only 2 percent on their retirement assets, they will be losing purchasing power against a 3 percent inflation of prices of goods and services,” he says. “With all the identified variables, if the couple retires at 65, into a 3 percent average annual inflation environment, the outcomes are very different based on projected rates of return on their retirement assets.”

He determined if they try to live on $110,310 today, by the time they are 75, they will need $193,653 in future dollars to meet that exact lifestyle. And if pensions and Social Security are only paying out under $7,000 per month, the shortfall snowballs over time if their investments don’t outpace inflation.

That means they will need to achieve a return on their retirement accounts 1 to 2 percent above the average annual inflation trends and manage their expenses/distributions wisely to have a comfortable retirement, Marchesi says.
Get With the Plan is designed to illuminate personal finance concepts and isn’t a substitute for actual financial planning or dedicated professional advice. To participate, contact Karin Price Mueller at Bamboozled@NJAdvanceMedia.com.